12 Reasons Why Traditional Asset Allocation Doesn’t Work

1.       Crashes and Low Returns (link)

Static asset allocation locks in the “Two Risks that Ruin Investing” - crashes and low returns. If you accept a static asset allocation strategy, you accept its history repeating in the future. For example, a 60/40 strategy drawdown of -63% in the 1930’s.

 2.       Low Conviction (link)

Data shows that most people cannot stick with their static asset allocation decisions, resulting in, what I call, the “Largest Cost to Investing” - the difference between dollar-weighted and time-weighted returns.

 3.       Mis-Definition of “Risk” (link)

Most asset allocations mis-define Risk and confuse it with Volatility.

 4.       Information Gaps (link)

Asset Allocation is determined by advisers and consultants; not asset managers.

 5.       Easily Replicated

Most static asset allocation portfolios can be replicated with a few index funds: stocks and bonds, with better results than actual portfolios due to the absence of poor tactical timing, redundant over-diversification, and high product fees.

 6.       A Pie Chart Mentality (link and link)

For most investors, Asset Allocation is a ‘pie-chart’ and not a personal investment philosophy, hence they abandon it too quickly.

7.       Noise & Randomness (link)

Poor recent results of over-diversification in asset allocation are largely driven by the harmful effects of randomness in the context of a flexible investment universe.

 8.       Risk-Tolerance Changes (link)

Most asset allocations assume static investor risk taking behavior, while risk-tolerance changes with the state of the market sentiment.

 9.       Unbalanced Risks (link)

Most dynamic asset allocations have too much strategy risk, not balanced with asset risk. You can see how this affects performance here.

 10.   Lack of Innovation (link, link, link, link)

Factor-based asset allocations under-estimate the low return risk due to low innovation.

 11.   Weak Validity (link)

Using long-run valuation ratios to time asset allocation decisions only works in non-implementable backtests.

 12.   Counter-Productive “risk-on” and “risk-off” Decisions

Strategic asset allocation that re-balances to an medium-term expected return target encourages counter-productive ‘risking up’ after bull markets and ‘risking down’ after bear markets.